OREANDA-NEWS. Fitch Ratings has upgraded Caixa Economica Montepio Geral's (Montepio, B/Stable/B) mortgage covered bonds (Obrigacoes Hipotecarias, OH) to 'A-' from 'BBB-' and removed them from Rating Watch Evolving (RWE). The Outlook is Stable.

The rating actions follow the restructuring of the OH to a conditional pass-through (CPT) from a soft bullet redemption on 1 July 2016 after the issuer obtained consent from a majority of covered bond holders. Fitch originally placed the OH on RWE upon the bank's announcement of the restructuring (see 'Fitch Places Montepio's 'BBB-' OH on Rating Watch Evolving' dated 17 May 2016 at www. fitchratings. com).

KEY RATING DRIVERS

The 'A-' rating is based on Montepio's Long-Term Issuer Default Rating (IDR) of 'B', an unchanged IDR uplift of 1, a revised Discontinuity Cap (D-Cap) of 6 notches (very low) from 0 notches (full discontinuity) and the 18% contractual overcollateralisation (OC) which provides more protection than the 17.5% breakeven OC for the 'A-' rating. The Stable Outlook on the OH reflects that on Montepio's IDR.

The 18% OC that Fitch relies upon is sufficient to make timely payments at the 'BBB+' tested rating on a probability of default basis and constrains the recovery uplift as it only allows to achieve recoveries given default of at least 51%, which corresponds to a one-notch uplift in a 'A-' rating scenario. The maximum achievable rating is 'A'.

The D-Cap of six notches reflects Fitch's very low risk assessment related to the liquidity gap and systemic risk component, which is now driving the D-Cap for this programme. The agency revised this component from full discontinuity as it recognises the restructuring removes the need to refinance assets in order to meet timely payments on covered bonds, should the recourse switch to the cover pool.

The programme also benefits from a rolling three-month liquidity reserve to cover for interest payments on the covered bonds, which is held by Elavon Financial Services Limited (AA/Stable/F1+). According to the programme documents, it is made available upon an issuer event or if triggered by a missed payment of interest, only after the five-business day grace period has elapsed. Fitch has taken this into account in its discontinuity assessment, as reflected by the 'very low' liquidity gap and systemic risk, instead of minimal discontinuity, which is typically assigned to CPT programmes with liquidity coverage.

As a variation to its "Covered Bonds Rating Criteria" Fitch did not apply the weak-link approach to determine the D-Cap of Montepio's OH but tied it to the assessment of the liquidity gap and systemic risk. The agency's analysis places a large weight on the protection against payment interruption risk, once the recourse against the cover pool is enforced, and does not consider the other components to significantly affect the discontinuity risk profile of this programme. If Fitch did not apply this variation, the covered bonds' rating would be two notches lower, at 'BBB' instead of 'A-'.

As part of its analysis, the agency also reviewed the asset segregation section of the programme's D-Cap to low from moderate discontinuity risk, taking into account the remedial actions implemented upon certain issuer events. This includes borrowers notification within 45 days and opening a programme account within 30 days with an eligible account bank, rated at least 'A-' as required by the Portuguese covered bonds law. The re-assessment also considers the by law segregation of cover pool and cash flows. In its cash flow analysis, Fitch has assumed a loss of a quarter of collections in the aftermath of an issuer insolvency and until the remedial actions are implemented.

The systemic alternative management section of the programme's D-Cap has been revised to low from moderate discontinuity risk, factoring in the alternative manager facilitated role in absence of asset liquidation. The other D-Cap components, namely cover pool-specific alternative management (moderate discontinuity risk) and privileged derivatives (low discontinuity risk) remain unchanged.

The greatest contributors to the 17.5% 'A-' breakeven OC are the credit loss of 9.4% followed by the asset disposal loss of 5.1%. The asset disposal loss represents the level of OC such that interest payments that become due on the covered bonds are modelled to be paid timely from the inflows of the cover pool, without a forced sale of the assets. The cash flow valuation (4.6%) is driven by the commingling loss that Fitch assumes in scenarios higher than the IDR adjusted by the IDR uplift. It also considers the absence of open interest rate positions (100% floating rate assets and liabilities). The Royal Bank of Scotland PLC (BBB+/Stable/F2) acts as asset swap provider for the programme.

The IDR uplift assigned by Fitch to this programme remains one notch, taking into account bail-in exemption for fully collateralised covered bonds and the domestically systemic importance of the issuer, as designated by the Bank of Portugal. Fitch believes that, if necessary, resolution methods other than liquidation are more likely to be applied by authorities to preserve important banking operations.

RATING SENSITIVITIES

The 'A-' rating would be vulnerable to downgrade if any of the following occurs: (i) Caixa Economia Montepio Geral's Issuer Default Rating (IDR) is downgraded by one or more notches to 'B-' or below; (ii) the number of notches represented by the IDR uplift and Discontinuity Cap is reduced to six notches or less; or (iii) the overcollateralisation (OC) that Fitch considers in its analysis decreases below Fitch's 'A-' breakeven OC level of 17.5%.

The Fitch breakeven OC for the covered bond ratings will be affected, amongst others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore the BE OC to maintain the covered bond ratings cannot be assumed to remain stable over time.